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Edited version of private ruling
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Ruling
Subject: interest expenses on a refinanced loan
Question
Are you entitled to a deduction for interest expenses on a refinanced loan used for income producing purposes?
Answer
Yes.
This ruling applies for the following period
Year ended 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
You have an interest only loan used for income producing purposes.
You wish to refinance this loan with another bank in order to obtain a better interest rate.
The refinanced loan will be for the same amount.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Summary
You are entitled to a deduction for the interest incurred on a refinanced loan as the money is still being used fully for income producing purposes.
Detailed Reasoning
Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.
Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.
The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.
Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. Further, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.
In your case, you have an interest only loan. You intend to refinance the borrowings from this loan with another bank. When you refinance your loan from one bank to another, the borrowed funds are still being used for income producing purposes. Both loans are arms length commercial arrangements. Accordingly, you will still be entitled to a deduction for interest incurred on funds used for investment purposes if you refinance the loan with another bank.